One of the most challenging issues in the financial management of the enterprise is the possible separation of ownership from management resulting in the so-called principal agent problem

Question

Define the agency problem, explain possible ways to alleviate the agency problem and discuss differences in across global markets.
What will be an ideal response?

Answer 1

Answer: The separation of ownership from management raises the possibility that the two entities may have different business and financial objectives. This is the so-called principal agent problem. There are several strategies for aligning shareholder and management interests, the most common of which is for senior management to own shares or share options. What is then good for the managers' own personal wealth is similar to that of general shareholders.
The United States and United Kingdom are two country markets characterized by wide-spread ownership of shares. Management may own some small portion of stock in their firms, but largely management is a hired agent that is expected to represent the interests of shareholders. In contrast, many firms in many other global markets are characterized by controlling shareholders such as government, institutions (e.g., banks in Germany), family (e.g., in France, Italy, and throughout Asia and Latin America), and consortiums of interests (e.g., keiretsus in Japan and chaebols in South Korea). A business that is owned and managed by the same entity does not suffer the agency problem.